A precipitous collapse of one of the nation's most respected corporations. Millions of average investors immediately affected by the collapse. Calls for government investigations and action. Congressional subpoenas of top executives. A public clamor for individual accountability.
This was Enron.
Now in the midst of the subprime mortgage crisis, with politicians capturing the froth of the average American with the sound bite "Main Street versus Wall Street," there is again a seeming mandate for criminal accountability.
As there was then, there are now elevated and misplaced expectations of easy indictments. In congressional hearings, former CEOs such as Richard Fuld of Lehman Brothers are being pressed to justify public statements regarding capital and liquidity positions in light of later capital infusions and bankruptcy.
My nightmare in prosecuting the Ken Lay case was the public expectation of an easy conviction on charges of insider trading, based on the publicly known fact that Mr. Lay had sold $70 million of Enron Corp. stock while making rosy pronouncements about his company in its final year of existence. Only later did investigators discover a labyrinth of margin calls that vastly complicated the case and ultimately deterred any insider trading charges.
Elevated public expectations effectively raise the bar of proof for prosecutors wary of "disappointing" jurors expecting a clear-cut case.
The public clamor for accountability in the subprime era produces an eerily familiar scene.
In congressional hearings, former CEOs are being pressed to justify public statements in light of internal documentation of business stress factors. Autopsies are being conducted on boards to determine whether they failed to exercise due diligence, were affirmatively misled, or were structurally incapable of fulfilling their roles as CEO advisers and sentinels. Rapidly deployed teams of SEC lawyers and state and federal prosecutors are competing with one another to stake early claims in anticipated cases.
Prosecutors and investigators have learned important lessons since Enron about the commitment of resources and the type of criminal proof persuasive to a jury in a corporate fraud case. These lessons will form familiar and new battle lines between prosecutors, corporations, and defense lawyers.
The Enron Task Force committed two entire squads from the Federal Bureau of Investigation — over 20 agents — to examining a single company for more than five years. But during the pendency of the Enron prosecutions, white-collar criminal agents nationwide were assigned to terrorism beats. Absent a radical redeployment of agents and an infusion of hiring funds over the next few months, the FBI will lack the resources for a comprehensive investigation of individual subprime companies.
In any event, prosecutors will not have the appetite to process FBI reports of possible accounting improprieties into complex indictments. The loss of the Scrushy/HealthSouth case underscored the elusiveness of a conviction in an accounting fraud case, even when the proof appears overwhelming.
As illustrated by U.S. Attorney Ben Campbell, the former Enron Task Force prosecutor, in his approach to the former Bear Stearns fund managers Matthew Tannin and Ralph Cioffi, post-Enron corporate fraud prosecutors will eschew accounting fraud charges in favor of straightforward false statement cases involving criminal hallmarks of self-dealing, such as insider trading.
False statement and self-dealing cases not only will have the advantage of juror appeal, but they also will not require squads of agents and thus will not overtax federal investigative resources.
And as in the Bear Stearns cases, agents and prosecutors will tend to wager only on those cases founded upon a hoped-for "smoking gun" document — normally an e-mail — that will permit easy and efficient proof of criminal intent. They will also seek at least one "cooperator" — an employee who has pled guilty to a lesser offense and seeks a sentencing break in exchange for assisting the government — to narrate allegedly incriminating documents and provide context to the jury.
How might corporate and individual targets respond?
Corporations are in a much stronger position now to fend off aggressive prosecutors and to help individual employees mount a robust defense.
Until recently, corporations under investigation saw the example of the Arthur Andersen prosecution as a warning that notice of an investigation meant surrender: waiving attorney-client privileged material, providing case material to expedite the prosecutor's case, and pressure not to pay the legal bills of accused employees and to sanction and terminate them before they were permitted due process.
The Supreme Court's reversal in the Arthur Andersen case shook the Department of Justice to its core. Rather than filing indictments against corporations, the department has retreated to filing nonprosecution or deferred prosecution agreements, which call for a probationary period in order to avoid indictment. Many corporations have been slow to realize that these agreements may be aggressively negotiated or avoided altogether, since the Department of Justice will not risk another corporate indictment that might be proven wrong only after another indictment or a verdict triggers an irreversible collapse.
Our now-frail banking system effectively means banks that formerly might have been a target of indictment will have virtually no criminal exposure in the subprime investigative era.
Companies involved in the subprime lending industry will benefit from recent court and congressional pressure to provide more protection for the attorney-client privilege and the attorney's work product.
New Department of Justice guidelines let companies retain attorney-client privileged work, including products of internal investigations, which prosecutors once routinely demanded and used as quick road maps for potential criminal cases. A company may no longer be pressured to deprive individual employees of indemnification for legal fees, eliminating an effective device wielded by some prosecutors to induce early guilty pleas and "cooperation" from financially cornered targets, so the prosecutors could pursue those higher on the corporate ladder.
White-collar investigative resources are currently stretched thin, limiting the points of prosecutorial attack. Corporations will be better equipped to parry, negotiate, and provide funded counsel to individual targets.
Other than periodic "roundups" of those involved in the processing of "liars loans," the number of subprime investigations that will ripen into actual prosecutions will likely disappoint the public. As with stock option backdating, the enormous initial interest in the subprime crisis will winnow to the point where a handful of the highest-level executives are portrayed in an apparent self-dealing moment while making alleged false statements by an errant e-mail or an equivalent "smoking gun" document.